ECONOMIC VIEW; Subjecting Greenspan's Theories to Peer Review

ECONOMIC theory is wonderfully pliable. Just when the Federal Reserve seemed to be running out of reasons to slow the economy in anticipation of a rising inflation rate that is taking forever to rise, Alan Greenspan has in the last 10 days come up with a new theory that requires the Fed to act, and quickly.

Mr. Greenspan's thesis makes productivity both a blessing and a curse: a blessing, because it raises the supply of goods and services, and a curse, because -- working through the stock market -- it increases the demand. The demand, in fact, outstrips the newly augmented supply. Shortages then raise prices and the inflation rate.

That is quite a mouthful of a theory, but one hard to ignore when coming from the Fed's august chairman. The same proposition, offered by an ordinary economist, would end up buried in an economics journal, peppered with challenges from peers.

Listen to peer review from Robert M. Solow, a Nobel laureate at M.I.T.: ''You cannot say that the Greenspan thesis is nonsense or cannot happen. But it is not enough to say that it is happening. You need a lot of numbers work to convince a person that what he says represents a clear and present danger.''

Fitting theory -- and policy -- to the facts has been a great source of angst lately at the Fed. To the Fed, as well as to many mainstream economists, the booming economy must result in too much demand and inflationary shortages. The problem is that shortages and inflation are not in sight. Still, the Fed has started down the path of higher rates to slow the economy and dilute demand.

That puts a lot of pressure on theory to justify a slowdown that will inevitably hurt a lot of Americans. Perhaps that is why Mr. Greenspan felt compelled to put a new layer of explanation on top of the two theories he has long proffered to explain how the nation has sidestepped rising prices this long but cannot do so any longer.

One holds that we have avoided shortages and inflation because the Asian crisis and a weak Europe diverted a lot of goods to America that could not be sold elsewhere. A strong dollar helped to keep the prices of these imports down, and oil was also abundant and cheap. Now, however, these ''favorable supply shocks'' are disappearing. The second theory says that the pool of available workers was deeper than anticipated, thanks in part to so many immigrants. But the pool is finally running dry and soon wages will rise as employers bid for workers. Companies will then raise prices to cover the higher wage costs.

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These are old-line theories shared by many economists and forecasters. The new one puts Mr. Greenspan out alone on a limb. ''Like any human being, he has his hunches and his sense of what is going on, and he is looking around for rationalizations,'' Mr. Solow said.

Mr. Greenspan's new rationale marries two observations. On the one hand, the economy is booming without inflation partly because productivity has risen; workers produce more goods and services per hour, and the revenue from the added output fattens profits and pays for raises, without higher prices. On the other hand, the voracious consumption that makes the economy so robust comes largely from rising stock prices; people feel wealthier, and this wealth effect prompts them to spend more than their incomes, borrowing to do so.

The new Greenspan link is this: The pickup in productivity has raised expectations that productivity will continue to rise, or at least level off at a higher rate than in the recent past. The prospect of better productivity ahead has raised expectations of higher corporate profits, and share prices have risen in anticipation, increasing the wealth effect and the spending. The rub, as Mr. Greenspan put it last week, is that the stock market is ''creating additional purchasing power for which no additional goods or services have yet been produced.'' So excess demand will create inflationary shortages, unless the Fed's higher rates reduce the steam.

That is a neat theory. The stock market may have gone way up for quite rational reasons, not irrational speculation. But does this theory square with the facts?

Mr. Solow, for his part, is not convinced that the wealth effect is really the source of so much spending and investment. And Mr. Blinder wonders whether most of the improvement in productivity is behind us, in which case Mr. Greenspan's ''thesis might be a better explanation of the last several years than the present.''

Mr. Greenspan's theory, in fact, may be one more explanation that fails to justify the Fed's decision to raise interest rates. For now, anyway.